Essentials

Bank Credit Analyst

In Section I, we argue that the December FOMC meeting has caused the “soft landing” narrative to penetrate the psyche of “Main Street”, which is now impacting the real economy. But if a pickup in sentiment and growth works against the pace of disinflation on which expectations of rate cuts were predicated, then the economy has a “circular reference” problem. A true “no landing” scenario would likely prevent Fed rate cuts, which would cause a large hawkish shock. That would put pressure on equity multiples via both a higher risk-free rate and equity risk premium. In Section II, we ask what policies investors should expect if Donald Trump wins the 2024 Presidential election. The answer is that a second Trump term would be much less positive for risky assets than the first.

Bank Credit Analyst

In Section I, we discuss the important flaws in the market’s “Goldilocks” economic narrative. Forward-looking measures of labor demand are heralding an eventual rise in the unemployment rate, and it is unlikely that this will occur in a benign fashion. This underscores that the US economy remains on a recessionary trajectory so long as monetary policy remains tight. Over the very near term, the Fed's December policy shift will remain a bullish factor for risky asset prices. But over a 6-12 month time horizon, investors should still be underweight risky assets and long fixed-income duration. In Section II, we review the post-World War II recessions to understand their causes and to see what indicators have been the most successful at signaling the end of recessionary selloffs in equity markets. We present an early draft “economic recovery checklist” for investors to monitor as a guide to determining when to increase one’s allocation to equities and other risky assets in the middle of a recession.

Bank Credit Analyst

In Section I, we discuss the implications and potential risks of the Fed’s recent pivot. The near-term implications of the Fed's dovish pivot are likely to continue to be bullish for risky asset prices, and a new high in global stock prices cannot be ruled out. The Fed has not effectively countered market expectations that monetary policy will cease to be tight in a year’s time, which has eased financial conditions and will work counter to the Fed’s economic forecasts. However, we would expect this, at most, to delay rather than to prevent a recession. Developed economies remain on a recessionary path so long as monetary policy in the US and euro area remains actually tight. As such, we do not see the December meeting as a truly bullish catalyst for risky assets on a 12-month time horizon. In Section II, my colleague Ryan Swift of BCA’s US Bond Strategy service reviews the outlook for the Fed’s interest rate and balance sheet policies for next year.

Bank Credit Analyst

Today, we are sending you the BCA annual outlook for 2024. The report is an edited transcript of our recent conversation with Mr. X and his daughter, Ms. X, who are long-time BCA clients with whom we discuss the economic and financial market outlook for the next twelve months toward the end of each year.

Bank Credit Analyst

In a guest authorship of Section I, Doug Peta presents a synthesis of the recent views expressed in our US Investment Strategy and Bank Credit Analyst reports. Doug underscores that excess savings are unlikely to support US consumer spending beyond the middle of next year, which argues for conservative investment positioning on a 6-12 month time horizon. Additionally, this month’s Section II is a guest piece written by Martin Barnes, who retired from BCA Research as Chief Economist in 2021 after a long and illustrious career. Martin expresses his personal views about the long-run outlook for inflation and argues that the multi-decade disinflationary era is over – which will bring significant challenges for both policymakers and investors.

Bank Credit Analyst

In Section I, we note that the recent surge in long-maturity government bond yields is symptomatic of a sharp reduction in market expectations for a soft-landing economic outcome. This underscores that the US and other developed market economies are on an ultimately recessionary path. We also discuss why the S&P 500 is likely to fall to between 3300 and 3700 in a recessionary scenario, and how OPEC 2.0’s production cuts will, at a minimum, reduce the odds of pre-emptive rate cuts. In Section II, we revisit the economic outlook for Canada, looking for signs that one of the most indebted economies in the world is buckling under the weight of tight monetary policy. We do find evidence suggesting that mounting debt service is already impacting Canadian consumers, and we expect to see a continuation of weak/weakening consumer spending in Canada so long as the current stance of monetary policy is maintained.

Bank Credit Analyst

In Section I, we respond to the ongoing challenge to our view that the US economy is on a recessionary path. The available evidence overwhelmingly supports the notion that US monetary policy is tight, which argues against the “no landing” economic scenario. It also underscores that the recessionary clock is indeed ticking unless the monetary policy stance eases soon. The “soft landing” narrative remains improbable and may have been unduly boosted by artificially low inflation readings over the summer. Until concrete signs of the meaningful rate cuts emerge, we will continue to recommend that investors maintain defensive portfolio positions. In Section II, we review the “modern-day” Phillips Curve, and explain why it is unlikely that the Fed will see a sustainable return to its 2% target without a rise in the unemployment rate above NAIRU.

Bank Credit Analyst

In Section I, we audit the market’s “soft landing” narrative in response to a meaningful challenge to our cautious stance from recent financial market developments. We acknowledge that US economic growth was stronger in the first half of the year than many investors expected, but we are unmoved by the recent uptick in “soft landing” hopes. A “soft landing” outcome very likely necessitates interest rate cuts before recessionary dynamics emerge, and it is far from clear that rate cuts or (especially) an easy monetary policy stance are likely to materialize over the coming year. As such, we continue to believe that conservative portfolio positioning is appropriate. In Section II, we discuss some simple approaches that we use when valuing the major asset classes that we cover. We conclude that global ex-US equities and ex-US developed market currencies are the main assets that can be considered “cheap” today.

Bank Credit Analyst

In Section I, we reiterate why a soft economic landing remains improbable in the US. Some reasonable estimates of the level of excess savings point to their depletion in a year’s time, but other estimates indicate a much earlier end point. We interpret this evidence, as well as other indicators, as pointing to an earlier rather than later US recession if the current stance of monetary policy is maintained or tightened further. In Section II, we provide an update on the US housing market. We acknowledge that permanent site residential structures investment may begin to contribute positively to US real GDP growth if the recent pickup in housing starts is sustained. But the recent housing market data is symptomatic of a negative housing supply shock that is far more consistent with the “no landing” economic scenario than the “soft landing” scenario that stocks are betting on. We continue to recommend that investors position their portfolios conservatively.

Bank Credit Analyst

In Section I, we review the three possible economic scenarios over the coming year, and underscore that the “soft landing” scenario remains improbable. A “no landing” scenario could occur, but it would ultimately lead back to the recessionary path and thus is not a basis for investors to maintain pro-risk portfolio positions. US stock prices continue to be buoyed by rate cut expectations, but nonrecessionary cuts still appear to be a long way off. In Section II, we present our best estimate of the inflationary threshold that results in a positive or negative stock price / bond yield (SBY) correlation, and whether investors are likely to approach this level over the coming one-to-two years. US core inflation does not likely need to return to the Fed’s target in order for the SBY correlation to return to positive territory, but a move back to a positive correlation will very likely occur in the context of falling equity prices.